Commodity Monthly Update - October

Balance POV

Supply

OPEC

AG exports saw an decline in October by 609 kbd MoM. This is in line with Saudi Arabia voluntary oil cuts to year-end as tightening supply and rising demand support oil prices. With Saudi Arabia continuing its oil cuts to year-end, we expect to see no significant changes to AG’s exports.

Russia

In October, Russia's seaborne oil exports surged to a four-month high, exceeding both its OPEC+ output commitments and pre-Ukraine war levels. Crude shipments from Russian terminals hit 3.53 million barrels per day (b/d), a 7.4% increase from the previous month. Despite a reduction in the discount of Russia's Urals crude to Brent, a significant share of exports targeted India and China. This uptick in crude exports contrasts with a decline in oil product exports, particularly diesel, which fell to a post-war low due to a temporary export ban aimed at controlling domestic prices. Overall, total Russian shipped crude and oil product exports reached 5.64 million b/d, slightly below pre-war levels, with vacuum gasoil flows experiencing the largest decrease. Russia managed to circumvent Western sanctions effectively, maintaining its oil trade with non-Western countries.

Iran

Iran's oil exports fell to a four-month low in October, with a decrease of 194,000 barrels per day from the previous month, amid challenges in tracking due to deliberate signal disruptions. The U.S. House has passed a bill proposing further sanctions on Iran's oil sector, although it awaits Senate approval and presidential sign-off. This comes against a backdrop of geopolitical tensions and U.S. political calls for a tougher stance against Iran after a Hamas attack on Israel, which Iran denies involvement in. Despite this, oil markets remain unperturbed due to OPEC+ output cuts ensuring ample global production capacity.

Demand

WoS

Demand in the WoS saw an increase of 26 kbd MoM. Factors such as lengthy tonnage lists, low inquiry levels, extended OPEC+ oil production cuts that caused a decrease in demand in the WoS have now largely or partially reversed, with the advent of the 4th quarter loading window, firming Persian Gulf-Far East and US Gulf-China markets and an increasingly tight tonnage list.

China

Imports from China have increased by 715kbd in October ahead of peak travel. With the long Golden Week holiday in October, refiners have stepped up purchases ahead of the travel period. Strong imports are expected as the demand for transport fuel in October has increased.

West

US Inventory and Production Update

In October, 3 out of 4 weeks saw a larger than expected build in US commercial crude oil inventories (excluding SPR). The most recent data (week ending Oct 27) showed an 800k bpd increase to 421.9 million barrels, 5% below the 5 year average. October’s data contrasts greatly with that of September, which showed an overall larger crude oil inventory draw in 3 out of the 4 weeks. For the month, refinery utilization rate fell by 0.3% to 85.4%.

Similarly, most recent data (week ending Oct 27) showed that finished Gasoline inventories continued their climb, rising by 100k barrels and are 2% above their 5 year average. Meanwhile, Distillate stockpiles decreased by 800k barrels and are about 12% below the 5 year average, and has seen draws consistently throughout the month. This clearly shows the strength of the distillate complex over gasoline, and we expect this trend to continue into the winter as heating oil demand rises

Though margins are lower this year compared to 2022 due to a looser balance, US Heating oil’s premium to Brent futures are still at elevated levels, around $11/bbl higher than the 5 year average. Therefore, we expect a drawdown of crude oil inventories in the month of November and going into the end of year.?

However, the El Ni?o weather phenomenon that is associated with warmer than usual weather patterns moving into America may result in a much warmer winter than previously expected, which would in turn lead to seasonally lower draws in distillate inventories and overall lower demand for crude.

As for the US Strategic Petroleum Reserve (SPR), Biden plans to replenish a total of 6 million barrels of crude oil by Jan’24 at around $79 a barrel or less which is higher than his previous preferred range of $70. SPR inventory levels still remain at 40 year lows of 351.3 million barrels.

US Crude oil production also hit a record high of 13.2 million bpd in the first week of October, surpassing pre-covid peak of 13 million bpd. This could be attributed to OPEC+ cuts which kept crude oil prices at elevated levels, and made it profitable for companies to continue producing. Only time will tell how much more crude production can grow from here, but this would help to lower domestic fuel inflation in the US and provide much needed support for Biden’s 2024 re-election campaign.

Fed

U.S. Federal Reserve officials have indicated the necessity for a continued restrictive monetary policy to reduce inflation to the Fed's 2% target. While there's agreement on this approach, discussions persist regarding another potential rate hike in 2023. Fed Governor Michelle Bowman expressed readiness to support an increase in the federal funds rate if required to reach the inflation target. Despite inflation dropping from 9% to approximately 3.7% following the Fed's interest-rate increments over 1.5 years, many central bankers believe another rate increase might be necessary. Fed Vice Chair Michael Barr emphasized the importance of the duration rates will remain high, while both Fed Chair Jerome Powell and Cleveland Fed leader Loretta Mester suggested restrictive policies might be needed for a significant period. Recent Fed forecasts reveal an anticipation of robust economic growth and job markets, with a slight modification in inflation predictions. Richmond Fed President Thomas Barkin commented on the resilience of the U.S. economy to external shocks and rate hikes. In light of the officials' emphasis on the potential need for prolonged restrictive policies and the ongoing discussion about further rate hikes, the overall sentiment of the U.S. Federal Reserve appears hawkish.

Macro indicators?

U.S. consumer spending witnessed a notable rise in September, driven largely by heightened purchases of motor vehicles and increased travel activities. This trend suggests a potential for robust economic growth as we move into Q4. However, a deceleration is anticipated by early 2024 as the surplus savings from the pandemic era are expected to deplete. Making up over two-thirds of U.S. economic activity, consumer spending accelerated by 0.7% in September, a significant jump from the 0.4% witnessed in August, and surpassing the anticipated 0.5% growth. The details reveal a 0.7% uptick in spending on goods such as prescription medications, new light trucks, and various food and beverages. On the other hand, service-related spending, encompassing sectors like international travel, housing, and utilities, saw an increase of 0.8%. When adjusted for inflation, consumer spending in September rose by 0.4%. This surge in spending has fueled the fastest economic growth observed in almost two years. However, there's been a decline in the savings rate, which fell to 3.4% in September from 4.0% in August, and personal income has seen a modest growth of 0.3% after a 0.4% rise in the preceding month.

September's inflation data presented a consistent picture, with the Personal Consumption Expenditures (PCE) price index gaining by 0.4%, mirroring the rise seen in August. In a year-over-year comparison, this index advanced by 3.4%, which was in line with August's metrics. Excluding the more volatile components like food and energy, the core PCE price index noted a growth of 0.3% for September. To reach the U.S. central bank's inflation target of 2%, economists emphasize the need for a sustainable monthly inflation rate of 0.2%. Data from September reveals that the core PCE index witnessed a year-on-year increase of 3.7%, a slight dip from August's 3.8%. A closer examination shows the super core PCE price index, which excludes energy and housing, registered a growth of 0.4% after a mere 0.1% increase in August, resulting in a 4.3% increase year-on-year for September. For their monetary policy strategies, the Federal Reserve is particularly focused on the PCE price indexes, with special attention to the super core PCE as a measure to assess their strides against inflation. Since March 2022, there has been a significant hike in the Fed's policy rate, with an increase of 525 basis points, bringing the rate to a range between 5.25% and 5.50%.

In light of the recent surge in U.S. Treasury yields coupled with a downturn in the stock market, the Federal Reserve is anticipated to maintain the current interest rates. While the growth in spending is commendable, concerns persist about its sustainability due to the rapid depletion of savings and an increasing dependency on debt. There is a consensus among economists that achieving a sustainable reduction in inflation towards the 2% target still requires more effort.

ECB halts rate-hiking cycle

The European Central Bank (ECB) is anticipated to halt its rate-hiking cycle, as predicted by 85 economists surveyed by Reuters. After 10 hikes in 14 months, September's 25 basis point rise, which took the deposit rate to 4.00% and the refinancing rate to 4.50%, is expected to be the last. The first rate cut's timing remains uncertain, with a median prediction suggesting it might happen in the third quarter of 2024, bringing the deposit rate to 3.5%. However, 40% of the respondents believe the rate cut could occur before July 2024.?

On the other hand, inflation in the Eurozone remains a concern. While it's on a declining path, September's 4.3% inflation rate is more than twice the ECB's 2.0% target. Inflation isn't expected to hit this target until at least the third quarter of 2025. External factors, such as the recent spike in oil prices due to concerns about the Israel-Gaza conflict and its potential escalation, play a role.

The economic health of the Eurozone is also not looking promising. Predictions suggest a stagnant performance for two consecutive quarters, largely influenced by increased borrowing and living costs. Germany, the largest economy in Europe, is projected to face a recession, whereas France seems to be on a more stable growth trajectory.

US Ease sanctions on Venezuelan Oil industry

US announced easing of sanctions on Venezuela’s oil industry, allowing state owned company PDVSA to export oil to its chosen markets for the next 6 months. The sanctions relief on Venezuela is unlikely to have an immediate impact on its oil production due to poorly maintained infrastructure and underinvestment in the country. However, the easing of sanctions could lead to a quick reshuffling of Venezuelan oil flows from China to the US, as Venezuela looks to capitalize on cash sales to the US instead of debt repayments to China.

Venezuela’s oil exports declined 19% in October to less than 700k bpd amid the easing sanctions due to operational hiccups, therefore further illustrating our view that a sustained output recovery would take some time.?

East

China PMI

The official manufacturing Purchasing Managers’ Index (PMI) dropped to 49.5 in October from 50.2 in September. This contraction in manufacturing activity was unexpected as the Reuters poll of analysts estimated PMI to be 50.2 in October too.

Fewer working days in October due to the Golden Week holiday, which spanned September 29 to October 6, affected the manufacturing PMI, according to the NBS.

Along with the drop in PMI, the MSCI China index has returned an average of -6.49% as of September 2023. Investments in the global markets have dropped.

The weak PMI data and MSCI China index may reflect some of the weakness in demand related to the housing slump and a slowdown in infrastructure spending. Both new export and import orders shrank for an eight consecutive month, suggesting that manufacturers were struggling for buyers overseas and ordering fewer components used in finished goods for re-export.

With China’s budget deficit being raised by the government, the economy could possibly revive slowly and cause an increase in demand for Chinese exports.

China Property Market Crisis + Stimulus Measures

China’s real estate crisis, which first started 2 years ago, has gotten worse recently.? Since the supply of housing does not match the much lower demand, possibly due to the aging population, investment in real estate has been falling. Shares in China Evergrande, China’s 2nd largest property developer, were suspended as the firm oscillated on the edge of bankruptcy. The company is estimated to have at least $328 billion in debt. This property downturn is likely to drag on, posing a major threat to China’s growth prospects over the next 3-5 years as the property market accounts for 30% of China’s economy.

China’s economic slowdown has weighed on everything from Chinese stocks to commodity prices. China is considering raising its budget deficit for 2023 as the government prepares to unleash a new round of stimulus to help the economy meet the government’s annual growth target. This includes added support for housing sales and lowering key interest rates. It will take time, up to a few years, for China’s economic growth to return to pre-pandemic levels and see a rise in commodity prices.

China Central Bank Policy and Interest Rates

China's central bank has been focused on lowering borrowing costs for companies and households and supporting banks in capital replenishment. Many Chinese local governments have begun issuing special refinancing bonds to repay outstanding liabilities as China's government focuses on reducing its growing debt.?

With 500 billion yuan worth of medium-term lending facility (MLF) loans maturing, the People’s Bank of China (PBOC) is pumping 289 billion yuan of fresh liquidity into the banking system. This is the biggest net injection in nearly three years.

The People’s Bank of China (PBOC) has also cut the MLF rate (a guide to China's benchmark lending rates) twice this year to lower borrowing costs in an economy hit by weak consumption and a deepening property crisis. However, the MLF rate remained unchanged in October at 2.5%. Industry experts are forecasting a 10 bps rate cut in december. This could potentially weaken the Yuan further as further monetary easing will widen China’s yield gap with the United States. (impact)?

Trade Idea

We proposed a SHORT EFS (ICE Brent Futures - M3 Dubai Swaps) trade idea on the 4th of November 2023. This idea rides on the tightening East West differentials in light of the easing of Venezuelan sanctions and poor western demand fundamentals. On the east, Venezuelan barrels being un-sanctioned would make the barrels pricier and less attractive to Chinese independent refiners, which have thus far prioritized sanctioned cargoes as feedstock due to their discounted prices and lack of import quotas. Chinese refiners may therefore may up middle eastern spot cargoes instead to meet demand, thus tightening the medium sour balance in the east.?

On the other hand in the west, Venezuela crude is likely to find its way to the US, where complex refineries have an appetite for medium to heavier grades of crude, thus loosening the Western balance further. However, EIA data has shown stock builds in both crude and gasoline in spite of refineries coming out of peak turnaround season. This paints an incredibly bearish picture for product and crude demand as stocks should be drawing in light of plants coming out of turnarounds. As a consequence, the western balance seems to be increasingly looser and in conjunction with potential Venezuelan supply coming to the west, projects an increasingly bearish outlook for western benchmarks.?

As of 8th November 2023, with reference to 3rd November 1630SGT prices,? EFS has gone from $1.03 to $0.51, while Dubai M3 is trading at $81.09 (from $86.18) and ICE Brent Futures is trading at $81.50 (from $87.21). Dubai M3 is down approximately 6% while ICE Brent is down 7%.